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Investors Holding T-Bills Due Tomorrow Get Nervous

Rates on the shortest Treasury bills surge as Fitch places U.S. credit rating on negative watch.

Investors holding $120 billion of Treasury bills coming due tomorrow are increasingly worried that they won’t get paid.

Rates on the bills, maturing the same day that Treasury Secretary Jacob J. Lew has said the U.S. will exhaust its borrowing capacity, have surged 16 basis points, or 0.16 percentage point, to 0.36 percent this week, according to Bloomberg Bond Trader prices. The securities, issued a year earlier, traded at a rate of negative 0.01 percent as recently as Sept. 26.

“That is how fear manifests itself,” said Marc Fovinci, head of fixed income at Ferguson Wellman Capital Management Inc. in Portland, Oregon, who helps invest $3.5 billion and holds about $500,000 of Oct. 31 bills in one account. “The market is discounting a day, or several days delay in payments.”

Lew told Congress last week the extraordinary measures being used to avoid breaching the debt ceiling “will be exhausted no later than Oct. 17” and the department will have about $30 billion to pay obligations if Congress fails to reach an agreement to lift the cap. Fitch Ratings placed the U.S.’s AAA credit rating on a negative watch yesterday, citing the government’s failure to raise its borrowing limit as the deadline approaches.

The Treasury should have enough money to pay off the Oct. 17 bills, according to Ira Jersey, an interest-rate strategist in New York at Credit Suisse Group AG, one of the 21 primary dealer obligated to bid at Treasury auctions. The U.S. raised $13 billion in “new cash” through yesterday’s sale of $65 billion in three- and six-month bills, which should leave the government with about $40 billion once the Oct. 17 bills mature, he said.

“After that the government is running on its last gallon of financial gas,” Jersey wrote in an e-mail. “After Oct. 24, the government will be running on fumes.”

The next securities maturing after the Oct. 17 debt are $93 billion of bills due Oct. 24. Rates on those bills have risen 20 basis points to 0.47 percent this week and touched 0.53 percent, the highest since they were sold in April. The rate was negative as recently as Sept. 27.

‘Close Enough’

“We are close enough to the deadline that, even if the latest headlines suggest the talks are progressing, there will be those risk-averse investors who decide they don’t want to hold those bills,” said John Davies, a U.S. interest-rate strategist at Standard Chartered Plc in London. “For many Treasury bill holders, a delayed payment can cause major problems and that means you have to shift your positioning, which creates selling pressure.”

The Treasury is scheduled to sell $68 billion in bills today, including $20 billion of four-week securities, $22 billion in one-year debt and $26 billion in 189-day cash management bills.

The sizes of the four-week and 27-week bills indicates the Treasury has “slightly more room left under the debt limit” than previously estimated, according to Wrightson ICAP LLC, an economic advisory company specializing in government finance.

“There is very little chance that the Treasury will have any trouble rolling over the Oct. 24 bills even if -- as seems quite possible -- the debt ceiling dispute drags into next week,” according to a commentary on the Jersey City, New Jersey-based company’s website yesterday.

The three-month bills sold yesterday drew a bid-to-cover ratio of 3.13, below the 4.52 average over the past 10 auctions. The high rate of 0.13 percent was the most since February 2011. The bid-to-cover ratio at the six-month bill auction was 3.52 versus an average of 5.07 at the previous 10 sales. It drew a rate of 0.15 percent, the highest since November 2012.

This was the second-consecutive week bill that auctions attracted lower-than-average demand amid the budget wrangling in Washington.

“The bill auctions were very poor,” said Thomas Simons, a government-debt economist in New York at primary dealer Jefferies LLC. “Unless there is some type of agreement in Washington, the bill market will continue to trade choppily and auctions will not go well.”

Senate leaders resumed talks aimed at avoiding a default and ending the government shutdown after the Republican-controlled House scrapped a vote on its plan.

Initial Conditions

Majority Leader Harry Reid, a Democrat, and Minority Leader Mitch McConnell, a Republican, had suspended their talks earlier while the House was considering its own bill. The House proposal contained almost none of Republicans’ initial conditions for ending the shutdown and raising the debt ceiling.

The emerging Senate agreement would fund the government through Jan. 15, 2014, and suspend the debt ceiling through Feb. 7, 2014. The Treasury Department could use its extraordinary measures to delay default for about another month beyond that, said a Senate Democratic aide who spoke on condition of anonymity to discuss the plan.

“Although Fitch continues to believe that the debt ceiling will be raised soon, the political brinkmanship and reduced financing flexibility could increase the risk of a U.S. default,” Fitch analysts Ed Parker, Tony Stringer and Douglas Renwick wrote in a report published yesterday. Fitch said it expects to resolve its rating watch negative outlook on the U.S. by the first quarter of 2014.

Moody’s Investors Service, which rates the U.S. a stable Aaa grade, reiterated that it expects the debt ceiling to be raised, averting a default. The company also anticipates “that the U.S. government will pay interest and principal on its debt even if the statutory debt limit isn’t raised.”

Standard & Poor’s stripped the U.S. of its top credit grade on Aug. 5, 2011, citing Washington gridlock and the lack of an agreement on a way to contain its increasing ratio of debt to gross domestic product. The ratio of public debt to GDP is projected to decline to 74.6 percent in 2015 after peaking next year at 76.2 percent, according to a Congressional Budget Office forecast in May.

“We do think what’s going on right now validates our decision to lower the rating one notch,” John Chambers, a managing director of sovereign ratings at S&P, said yesterday in an interview on Bloomberg Television’s “Surveillance.” “We think there will be an 11th hour deal, and that is our working assumption.”

Record Low

While the S&P downgrade didn’t result in investors charging the U.S. more to borrow, as 10-year yields fell to a record 1.38 percent in July 2012, the move contributed to a global stock-market rout that erased about $6 trillion in value from July 26 to Aug. 12, 2011.

Citigroup Inc. is bracing for a possible U.S. default by avoiding some short-term Treasury investments amid what Chief Executive Officer Michael Corbat called “a dangerous flirtation with the debt ceiling.”

Corbat made the remark during a conference call yesterday to discuss third-quarter results at New York-based Citigroup. The bank doesn’t own Treasuries that mature in October and holds few with terms ending before Nov. 16, Chief Financial Officer John Gerspach said.

Although rates on bills have risen, they are lower than historical levels. One-month rates have averaged 1.5 percent in the past 10 years. During that time they touched a high of 5.26 percent in November 2006 and dropped to a low of negative 0.09 percent in December 2008.

Two years ago, one-month rates climbed to a 29-month high of 0.18 percent as the Aug. 2, 2011, deadline set by Treasury to avoid a default approached. They traded at negative 0.046 percent in December 2012 before a year-end trigger that forced automatic spending cuts and tax increases.

The Bipartisan Policy Center, a Washington-based nonprofit research group, estimates that the Treasury will actually be unable to pay all the government’s bills on time at some point between Oct. 22 and Nov. 1. While the Treasury will probably be able to delay the true drop-dead date for a few days, it is unlikely to be able to do so beyond Nov. 1 because several large payments are due before then, the center says.

“There’s just a general interest in the market to be out of any paper in the market that could potentially be impacted by the debt ceiling in any way,” said Andrew Hollenhorst, fixed-income strategist at Citigroup in New York. “That’s just general concern around the debt ceiling and concern around something the market doesn’t feel it completely understands.”

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